ESTIMATING EQUITY RISK PREMIUM: THE CASE OF GREATER CHINA

Abstract

The expected equity risk premium is a key input of many asset prcing models innance. There exist a number of methods to estimate the risk premium. It is alsowell documented that the risk premium is time-varying. This paper briey reviews twodi¤erent approaches. More specically, the historical average and relative estimationare taken into closer examination. The rst approach is applied to estimate equity riskpremium for stock markets in Greater China when the stock markets were recoveringfrom the bottom. Then the relative estimation approach is also adopted to empiricaldata to justify the ndings in the rst one, which takes into consideration the lowerrequired rate of return for Chinese investors due to lack of investment opportunities.After making these adjustments, we nd that risk premium in mainland China is close torisk premium for Hong Kong and Taiwan markets. All of those markets have higher riskpremium compared to US market. The risk premium for Shanghai and Shenzhen marketare about 8% and 10% respectively. For Hong Kong and Taiwan these numbers become8% and 9%, where the long-term forward-looking risk premium for US market is about4%.